A bill that would extend a key tax break to tens of thousands of short sale sellers who sold their homes in 2014 for less than they owed on their mortgages was passed by the House and the Senate in late December, 2012. The last-minute one-year extension of the Mortgage Debt Forgiveness Act, which expired December 31, 2013, was included in the Tax Increase Prevention Act of 2014 that was signed into law by President Obama on December 16, 2014. Short sale advocates and real estate groups have been lobbying hard all year to help homeowners who sold their home through a short sale avoid a devastating tax bill, which they likely could not afford.
Traditionally, if a lender allows a homeowner to sell real estate for less than the amount owed on the mortgage, the homeowner has to report that forgiven debt as taxable income to the Internal Revenue Service. The Mortgage Debt Forgiveness Act of 2007, which had been extended multiple times, allows taxpayers to exclude that forgiven debt from their annual income calculations. The tax break lapsed in 2013, forcing homeowners to either gamble that it would be revived and proceed with a short sale or remain in homes that they either could not afford or could not sell because the mortgages were underwater.
An analysis earlier this year by the Urban Institute concluded that uncertainty over whether the tax break would be renewed could affect up to two million seriously underwater borrowers, including some who would eventually fall into foreclosure. The Act has only been extended through 2014. Congress is expected to debate further extension of the Act as part of a larger tax package in 2015. In the meantime, mortgage debt forgiven by a lender in 2015 might count as taxable income.